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11

Imperfect Competition 11

11.1 What Does Equilibrium Mean in an Oligopoly?

11.2 Oligopoly with Identical Goods: Collusion and Cartels

11.3 Oligopoly with Identical Goods: Bertrand Competition

11.4 Oligopoly with Identical Goods: Cournot Competition

11.5 Oligopoly with Identical Goods but with a First-Mover: Stackelberg Competition

11.6 Oligopoly with Differentiated Goods: Bertrand Competition

11.7 Monopolistic Competition

11.8 Conclusion

In previous chapters, we studied the two ends of the market power spectrum: perfect competition and monopoly. In perfect competition, a firm has no market power because it is only one of many producers in the market, the price is driven down to marginal cost, and output is relatively high. In a monopoly, one firm has market power because it is the only producer of a good in the market, price is greater than marginal cost, and output is lower. We also learned about the many pricing strategies that firms with market power can use to earn greater economic profit.

imperfect competition

Market structures with characteristics between those of perfect competition and monopoly.

Between these two ends of the spectrum are lots of industries, most of them perhaps, that are neither perfectly competitive nor monopolistic. Coke and Pepsi dominate the cola market together. Nintendo, Sony, and Microsoft dominate video games. These companies compete but are hardly perfectly competitive. Yet they aren’t stand-alone monopolies either. The industry structure between perfect competition and monopoly is known as imperfect competition.

oligopoly

Competition between a small number of firms.

This chapter introduces that important but sometimes complicated market structure. We begin by looking at several types of oligopoly, a market structure characterized by competition among a small number of firms. Because there are many possible ways in which oligopolistic firms compete, there is no single model of oligopoly that is applicable to every situation. One theme of this chapter is that having a few competitors in an industry—rather than many or only one—can lead to multiple possible price and output outcomes. Several kinds of price and quantity outcomes could occur in an oligopoly, depending on the market circumstances. This isn’t the case with perfect competition or monopoly. With perfect competition, price equals marginal cost and the market’s output equals the point on the market demand curve at that price/cost level. With a monopoly (ignoring price discrimination), the firm equates marginal revenue and marginal cost to determine its output, and the price corresponds to the level of the demand curve at that quantity.

With oligopolies, firms have some market power but not necessarily monopoly power, and there is some competition but not perfect competition. This means that we need to be a little more specific about aspects of the particular market we’re studying before we can figure out what prices they will charge, how much each company will produce, and how much profit each firm will earn. Just knowing how many companies are in the market is not enough to analyze behavior in an oligopolistic market. Other factors that have an effect on price and quantity decisions in an oligopoly include whether the companies make identical products (as in an oil oligopoly) or products that are slightly different from one another (like Coke and Pepsi), how intensely the companies compete, and whether they compete with one another by choosing the prices they charge or the quantities they produce.

monopolistic competition

A type of imperfect competition with a large number of firms in which each firm has some market power but makes zero economic profit in the long run.

In this chapter, we present five of the most common models of how oligopolies behave, plus one additional model of a type of imperfect competition called monopolistic competition, a market in which a large number of firms have some market power but each makes zero economic profit in the long run. Whenever you have this many models as possible explanations for market behavior, it’s important to figure out which one is appropriate for a specific case. This decision isn’t always obvious in practice, so we discuss some ideas for determining which model is most appropriate for various real-world situations.